Question #82
Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers
PDF File: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers.pdf
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Question
A putable bond with a 6.4% annual coupon will mature in two years at par value. The current one-year spot rate is 7.6%. For the second year, the yield volatility model forecasts that the one-year rate will be either 6.8% or 7.6%. The bond is putable in one year at 99. Using a binomial interest rate tree, what is the current price?
Answer Choices:
A. 98.190
B. 98.885
C. 98.246. Explanation The tree will have three nodal periods: 0, 1, and 2. The goal is to find the value at node 0. We know the value at all nodes in nodal period 2: V2=100. In nodal period 1, there will be two possible prices: Vi,U = [(100 + 6.4) / 1.076 + (100+6.4) / 1.076] / 2 = 98.885 Vi,L = [(100 + 6.4) / 1.068 + (100 + 6.4) / 1.068] / 2 = 99.625. Since 98.885 is less than the put price, Vi,U = 99 V0 = [(99 + 6.4) / 1.076) + (99.625 + 6.4) / 1.076)] / 2 = 98.246. (Module 27.2, LOS 27.f)
No explanation available for this question.